Insurance is a risk management tool that typically involves aggregating funds received through premiums payments from many people. These aggregated funds are used to pay for covered losses. Insurance companies often evaluate the risk of an individual through the application process. An applicant for insurance generally must meet certain criteria set forth by the company in order to be insured. Depending on the type of insurance being applied for, the insurance company can require medical exams, medical history, background checks, driving history, credit checks, and other types of information to assist in the evaluation of the individual applying for the insurance coverage. Based on the information gathered during the application process, the insurance carrier can decide to issue an insurance policy laying out the details of coverage such as terms, obligations, excluded events, covered events, premium amounts, and the like. Typically, the more risk associated with an individual, the higher the premiums the insurance companies will require the individual to pay. In some cases, an insurance company may be unwilling to even insure the individual.
A reserve fund is created from the aggregated funds with a sufficient present value to cover the expected value of future claims. The reserve funds are typically invested in less liquid assets with growth potential. This is in contrast to unsettled liabilities which must be kept in more liquid investments until the liability is settled. As a result, there is a benefit in keeping a maximum balance in the reserve fund. The faster the claim is settled, the faster excess funds can be returned to reserve for potentially higher returns.